China To Maintain Neutral Monetary Stance, Raised Concerns On Inflation

In the quarterly Monetary Policy Report for 2Q14, the PBOC acknowledged that economic growth was stable in the first half of the year and expected growth would improve in the second half. It also delivered a more hawkish view over inflation and noted the debt levels have risen too fast. On monetary policy outlook, the central bank reiterated its neutral stance. In our opinion, rising inflation concerns might present limitations for the PBOC to adopt aggressive easing while recent improvements in economic data might have reduced the need for doing do. However, more easing measures are still likely as the government struggles to achieve the growth target of +7.5% this year.

The weighted average lending rate for non-financial companies fell in 2Q but remained at an elevated 6.96% (down -0.22% from March). The problem that small firms are facing financing difficulties and high funding costs remained obvious and the PBOC attributed this to structural issues behind the unmatched funding needs. Given that such problem is not easily solved by broad monetary easing, it’s likely that the central bank future monetary policy decisions would be more focused on specific sectors.

The central bank showed concerns about upside inflation risks despite muted inflation readings over the past months. While noting that the current price condition was stable, recovering demand could stoke inflation in the future. Indeed, inflation had been benign over the past months CPI grew +2.3% y/y in June, down from a +2.5% increase in May, due to lower food inflation after a spike in May. We are instead concerned about the potential disinflation in the housing market as the government’s tightening restriction on housing has lowered transaction volumes to fall and raised inventory. The government’s concerns over the rising inflation should restrain it monetary easing decision going forward.

The monetary policy outlook remained largely the same as 1Q14. Yet, the emphasis on funding costs in the real economy and the structural problems in the financial industry suggests that the PBOC’s future monetary decision would focus on distribution of liquidity, instead of liquidity. While a hawkish stance over inflation might present limitations and recent improvements in economic data might refrain the PBOC from easing aggressively, more stimulus are still likely as the government struggles to achieve the growth target of +7.5% this year.

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